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Why Rising Budget Deficits Don’t Scare Wall Street

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By Michael Rainey

April 24, 2019

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Some economists see America’s large and growing budget deficits as a problem requiring urgent attention, but Bloomberg’s Katia Dmitrieva and Liz McCormick say that to many investors, the fiscal gap looks more like a solution to several pressing issues.

In the face of rising uncertainty about a slowing economy in Europe and possible credit woes in China, investors are increasing their demand for safe assets, the authors say, and the debt issued by the U.S. Treasury to cover the soaring deficits under President Trump fits the bill nicely.

Thomas Wacker, head of credit research at UBS Global Wealth Management, told Dmitrieva and McCormick that people buy U.S. Treasuries when they are worried, and with “so many things cooking everywhere” in the world right now, “there’s a constant flow into dollar debt.’’

U.S. government-backed debt is particularly appealing because, unlike some other advanced countries, including Germany and Japan, it provides a positive yield (see the chart below).

Some experts argue the increase in the supply of safe assets could have a stabilizing effect on the markets, in part by reducing the need for private debt issuers to create exotic instruments that attempt to mimic the performance of government debt – a dynamic that ended disastrously in the financial crisis 10 years ago. “When the government spends money and borrows money, it’s creating safe assets. That’s the thing that’s being missed,’’ said J.W. Mason, an economist at the liberal Roosevelt Institute.

One thing seems certain, though: With trillion-dollar annual deficits coming as soon as this year, the U.S. will be issuing lots of safe assets in the foreseeable future. Aside from the immediate worries about the health of the global economy, the need for safe and stable retirement funds to provide for an aging population will likely play a significant role in maintaining demand for U.S. debt, Dmitrieva and McCormick say. And although many fiscal hawks are certain that rising public debt will push up interest rates, potentially sparking a fiscal crisis of spiraling debt costs, market participants aren’t so sure.

Andrew Milligan, head of global strategy at Aberdeen Standard Investments, told Dmitrieva and McCormick that “when the U.S. Treasury market explodes due to more issuance, you’ll be seeing a lot of investors simply dashing for safety and buying that debt.” In a dynamic he called “peculiar,” Milligan said that “Supply often creates its own demand in the bond market.’’